Covance (NYSE: CVD) turned in yet another admirable quarter, but that didn't stop the market from bidding down the drug-development services company's shares 6% on Thursday. Investors seemed to fret over the company's full-year earnings forecast, but the facts suggest that Covance remains a solid long-term bet.
The Princeton, N.J.-based firm reported that third-quarter net revenue jumped 15.2% to $295.4 million and net income increased 24.1% to $31.2 million, which translated into $0.49 per share. Covance continues to exhibit operating improvements as operating margins this quarter reached an all-time high of 14.9%, up from 14.1% in last year's third quarter. And the company is not done yet. It expects to churn out higher margins in the future thanks to economies of scale, more profitable service mix, automation, and a Six Sigma program of continuous improvements.
As for business flows, Covance doesn't seem to have a lot to worry about. Backlog rose 4.5% sequentially and 19% year over year to $1.57 billion. What's more, the firm remains committed to insulating itself from the vagaries of cancellation that plague contract service providers. In that vein, Covance is currently in negotiations to sell dedicated capacity for new space at its Madison, Wis., facility.
On a cautionary note, Covance did disclose in its investor presentation that contract research organizations (CROs) as an industry are growing faster than the pharmaceutical sector's research and development spending. However, this imbalance should be offset partially by increased levels of outsourcing from big drug outfits. In light of its recent weak showing, Motley Fool Inside Value pick Pfizer (NYSE: PFE), for instance, may be more inclined to cut costs by outsourcing. Furthermore, Covance's size and global footprint make it one of the more attractive CROs for prospective clients, so it should be able to take business from competitors.
Covance's confidence in its future was reflected in its raising of its 2005 earnings guidance from $1.88 to at least $1.91 per share. The latter figure was a penny short of consensus estimates, a fact that may have helped drive the stock down. But Covance's fat backlog and expectation of higher operating margins are strong reasons to hold onto to the stock.
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Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.
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